Almost 200 countries have signed the Paris Agreement: a pledge to keep the global temperature rise well below 2 degrees Celsius. To realize this pledge, global greenhouse gas emissions will need to be reduced substantially. This, in turn, requires a global transition to a low-carbon economy and energy system.
Such an energy transition may give rise to shocks that could be disruptive for the financial system. This Occasional Study investigates the potential financial stability impact of a disruptive energy transition for the financial sector of the Netherlands by conducting a stress test.
Several organizations have recommended the use of stress tests in relation to climate-related risks. The European Systemic Risk Board (2016), for example, recommends European Supervisory Authorities to include a disruptive energy transition scenario into their stress test exercises.
Similarly, the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (2017a) has recommended firms to use scenario analysis and stress testing in the context of climate-related risks. To date, however, practical experience with stress testing climate-related risks is still limited. In addition to shedding light on the financial stability risks for the Netherlands associated with the transition to a low-carbon economy, therefore, this study attempts to make a contribution to energy transition risk stress testing.
In the transition to a low-carbon economy, risks to financial institutions and financial stability may arise. At present, fossil fuels still hold a central place in the production and consumption of energy. Economist Nicholas Stern has pointed out that because of this, the necessary reduction in CO2 emissions will require drastic changes to the global economy and energy systems (Stern, 2008, especially pp.7-8).
In a speech to the UK insurance sector in 2015, Bank of England governor Mark Carney warned that this energy transition could give rise to financial risks (Carney, 2015). In particular, technological breakthroughs or abrupt changes in government policy may trigger a reassessment of asset values which could affect financial institutions’ balance sheets. If this were to happen on a large scale, there could be an impact on financial stability.Read more